Analysis: Graft crisis may hand India "Eureka" moment on reform

Reuters News
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Posted: Aug 30, 2011 1:28 PM
Analysis: Graft crisis may hand India "Eureka" moment on reform

By Alistair Scrutton

NEW DELHI (Reuters) - If the optimists are to be believed, India's huge anti-corruption protests may give impetus to a beleaguered government to push its reform process and help ailing economic growth and plummeting business confidence.

If so, it comes not a moment too soon. Hit by high interest rates and policy paralysis, economic growth in April-June looks set to slow to its worst in six quarters [ID:nL4E7JQ1TN]. August business confidence by one leading survey has plummeted to a two-year low.

The fast by social reformer Anna Hazare not only forced parliament to move on an anti-graft bill, it may have woken the ruling Congress party to the fact governance is more important than playing populism with regional and caste-based votes.

"The last year has been one of drift and policy paralysis and the pummeling of the government by Hazare was the last straw," said V. Ravichandar, chairman of Feedback Consulting in Bangalore, which advises multinationals.

"The government just cannot afford to play dead any more."

In power for most of India's independence and with its roots in Soviet-style five-year plans, the left-of-center Congress emerged as the party of the poor villagers. The rising middle class has often played second fiddle.

Hazare, who ended his fast on its 13th day on Sunday, may have been a turning point. Hundreds of thousands of the urban, middle class took to the streets, confounding those who saw the sector as a political footnote compared to the rural majority of India's 1.2 billion population.

The way to win over that urban, young middle class behind Hazare may be to boost the urban economy and reforms like foreign investment in the modern supermarket sector, making it easier for industry to acquire land and the creation of national, streamlined taxes.

"Now the government may want to take the high ground, and reforms may be one way to achieve that. Congress may realize it can no longer just pander to rural and poor votes," said Ravichandar.

And pander it has -- for years.

The government spends a huge amount on subsidies for the mainly rural poor, including a rural employment scheme that is widely seen as allowing it to win its second term in 2009. That now accounts for more than three percent of the annual budget.

The cost of food subsidies has roughly tripled since Prime Minister Manmohan Singh first came to power in 2004, to 600 billion rupees ($13 billion), according to a report by Standard Chartered Research.

At the same time, the government has gone slow on reforms like opening up supermarkets to foreign investors, a move that would help India's stubbornly high inflation rate and ease the burden of India's urban classes hurt by rising food prices.

ECONOMY SLOWS

"At the moment India suffers from a double whammy of policy lethargy and high interest rates," said D.K. Joshi, principal economist at Crisil in Mumbai. "Confidence will be boosted if the government moves on reforms. People want to know that it is smoother to invest on the ground."

Ominously, car sales fell in July by nearly 16 percent, the first drop in two and a half years, as fewer consumers can afford to get affordable car loans. China's sales rose nearly 7 percent in the same month.

The central bank, which has been one of Asia's most aggressive central banks by raising rates 11 times since last March, has warned against accepting inflation as a "new normal."

Some analysts say economic growth may slow to seven percent if there are no reforms, not enough for Asia's third-largest economy that needs to grow nearer double digits to compete with the likes of China and deal with its widespread poverty.

"The Anna Hazare movement itself is a reflection that things are not moving. Some positive things must happen now otherwise it will be a disaster," said a finance ministry adviser, who asked to remain anonymous.

The last week of parliament will see investor eyes on whether Congress pushes through reforms, with only a week of the session left.

These measures in themselves are no magic wand. But what they may install -- relatively quickly -- is business confidence, and with it a more benign investment climate.

The August report on business confidence by the Federation of Indian Chambers of Commerce and Industry came before Hazare's anti-graft campaign transfixed India. The survey said weak demand and high rates were two of their biggest concerns.

The survey said business was looking for big-ticket items, including a reform to streamline taxes that may be introduced by the 2012 fiscal year

PESSIMISTS - HISTORY ON THEIR SIDE

If the pessimists are to be believed -- and they have history on their side -- a rudderless leadership may hold India back.

The government's fumbling response to Hazare, briefly arresting him before releasing him after a protest backlash, only underscored how out-of-touch Singh and his elderly ministers are.

Finance Minister Pranab Mukherjee is the wily political firefighter of the government and was key to reaching a compromise with Hazare. But there were frustrations his gaze was not on the $1.6 trillion economy.

"Yes, unfortunately, the government has been caught up in defusing this crisis. I must admit even here in the finance ministry, policy decisions have been held up," said another senior finance ministry official who declined to be named.

"I have not met the finance minister for more than three days and decisions on the table have been held up."

The Congress party is also without Sonia Gandhi after she underwent surgery in the United States for an undisclosed illness. Her son, Rahul Gandhi, has shown little leadership qualities, remaining mostly sidelined during the Hazare dispute.

Singh may have been responsible for the 1991 reforms that set the stage for India's two-decade boom, but he has shown an inability to push aggressive reforms in his second term.

Still, the deal with Hazare saw unusual parliamentary consensus between the Congress and opposition, and some analysts say there is a chance this will feed into the reform bills.

The Hazare crisis may also soon spark the rise of Rahul Gandhi and some younger politicians unshackled by the decades-long statistic history of Congress.

"Now it is all behind us, the government will be able to concentrate on reforms," said Shubhada Rao, chief economist at the Yes Bank in Mumbai.

"These may have a medium-term impact, but what is important is to boost business confidence."

(Additional reporting by Manoj Kumar, Abhijit Neogy and Nigam Prusty; Editing by Paul de Bendern and Nick Macfie)